Prices only collapse in particular conditions. Two general terms for contrasting market conditions are “seller’s market” and “buyer’s market.”

A buyer’s market means that the buyers of that particular type of purchase have the advantage. In brief, a buyers market is whenever there is more offers to sell than offers to buy (bids). When there is a growing imbalance between the many numbers of offers to sell and few offers to buy, then the relative cost of a purchase tends to decline. If selling pressure floods in to the market at the same time as buying pressure is withdrawn, prices can suddenly collapse.

An example of buyers markets would be when there is a very low employment rate in an area and a truck shows up where there are a bunch of able-bodied and willing workers and there is announcement of work available. People may crowd together or line up in order to get selected early and be hired and earn their pay. If there are only two employers in an area and then one of them leaves, the cost of labor for the remaining employer can plummet. Suddenly jobs are more scarce and available workers are more plentiful.

In other words, in buyer’s markets, the buyers have the advantage because the buyers are relatively scarce, meaning that there are a lot more sellers than buyers, so that, in an extreme case, the buyers are the ones who can publicize to the sellers “I am buying” and then wait for the sellers to come to them and compete against each other to get the business of any particular buyer. There is a large supply of whatever is being sold relative to the existing demand to buy that purchase.

So, another way to describe a “buyer’s market” is “saturated” or “over-saturated,” meaning that there is a lot more supply available than the demand available. Other similar terms are “shortage” and “surplus” (in terms of supply or inventory relative to demand) as well as “boom and bust” (relative to demand).

The opposite condition from a buyer’s market is of course a seller’s market in which offers to buy are plentiful and offers to sell are scarce. For instance, when qualifications to get real estate financing are reduced, that can produce a flood of newly qualified buyers.

Loans (Photo credit: jferzoco)

Let’s say that a government program subsidizes purchases for a particular favored population, such as military veterans, at the expense of all other taxpayers. Further, let’s say that lenders reduce the qualifications for a loan, such as reducing the credit score required and reducing the down payment from 10% to 1%. We can see how this would increase the number of qualified borrowers, right? Further, let’s add that there is a natural disaster such as a wildfire that suddenly destroys 30% of the homes in an area. In that case, we have a sudden reduction in the number of homes available, plus a sudden increase in the number of qualifying borrowers (such as from higher-risk lending by lenders and/or government favoritism to subisidize a particular groups’ purchases). What is likely to happen to prices?

If only temporarily, prices tend to increase when there is a relative increase in buying pressure over selling pressure. Once the new wave of buying is complete, as most of the people who suddenly qualify may complete their pucrhases, then there would be very few prospective buyers left. Where would the next wave of buying come from? In the absence of a sudden decrease in the number of units available for sale, prices eventually could be expected to come back down toward prior levels, especially if the policies end that had increased the buying pressure.

In a seller’s market of relatively scarce supply, a salesman can come in to a public area with an announcement of their offering, such

SALE (Photo credit: Gerard Stolk (vers le Midi Carême))

as snake oil, and people may crowd together in a bidding war to get one of the very few bottles of snake oil (or bottles labeled snake oil). Similarly, an auctioneer can announce foreclosure auctions and a herd of people will gather in a bidding war- if it is a seller’s market in which there is relatively high demand for whatever is being sold.

Or, in the case of recent real estate markets as changing lending policies produced huge surges in the number of qualifying purchasers, sellers can list their homes for sale with a realtor and just wait for bids to come in. In a true seller’s market, owners do not even have to list their item for sale and they may get offers to buy anyway. Buyers do not even wait for offers to sell in extreme cases of seller’s markets.

Another common example of a seller’s market would be when a big business operation (such as a government) is inviting bids to perform a particular construction project. The herd of contractors learn of the opportunity, research the project and then make their bids. From all of the bids submitted, a selection can be made. The seller does not need to do much to attract the attention of a herd of buyers during a seller’s market.

Sale (Photo credit: Gerard Stolk (vers le Midi Carême))

So, why do prices collapse when a seller’s market shifts to a buyer’s market? One thing is that everyone who owns a particular type of item has been thinking that recent market prices reflect the market value of their item. After all, that is how accountants and tax forms instruct us to estimate the value of something: from a “comp” or recent transaction price for a similar purchase.

Imagine that there are 1,000,000 tons of silver actually available for sale. On a typical day, imagine that only 100 tons are actually exchanged in a sale. So, people look at the going rate for the sale of 100 tons of silver and think that if all the other 999,900 tons of silver were to be sold on the same day, the price of all 999,900 would be the same as the price for the first 100 tons sold that day. That is ridiculous, but that is the conventional method of accounting the value of all 1,000,000 tons of silver. That issue is how silver prices can fall 19% in one day, such as in April of 2006. In the case of certain changes to qualifications to borrow money to buy silver (margin regulations), then the fundamental naivete can quickly be revealed of thinking that the daily price for selling 100 tons of silver is a decent estimate of what the daily price would be on a day that 10,000 tons are suddenly made available for sale. Unless the buying pressure also increases to meet the new selling pressure, of course prices will plummet.

Or, consider the stock price of a large, stable corporation such as Enron. One day, there may be 1,000,000 shares of Enron available in the marketplace, but imagine that only 100 are actually sold in a typical day. The share price might be $7 or $8 on a typical day, (such as Nov. 20, 2001 shown above) but then what if the next day 100,000 shares of Enron are placed for sale at “market price?” If there are not 100,000 offers to buy (bids) waiting to match all 100,000 offers to sell, the market price of the remaining unsold shares listed for sale falls to ZERO, right?

Of course, buyers may show up the next day and purchase the remaining shares unsold but listed for sale (all 99,900) for something like thirty cents per share. What happened to the other 900,000 shares that were estimated as worth $7 each the day before and now are estimated as worth thirty cents each?

Well, the prior estimates over-looked that there suddenly could be a relative increase in selling pressure. If selling pressure rises dramatically and is not matched by a sudden rise in buying pressure, prices plummet, whether prices of silver or Enron or anything else.

There is a chart of what happened when a lot of the owners of Enron stock wanted to sell Enron shares and very few people wanted to buy it: it fell from every single share of Enron stock being accounted as worth $85 a share to zero. Here is a similar chart for the entire stock market of Japan, peaking in 1989, then the trend of more buying pressure than selling pressure reversed to more selling pressure than buying pressure:

When oil prices doubled in less than a year in 1999, there was a relative increase in selling pressure in the sector of the US stock market for airlines, measured as a 40% decline in price:

When the US stock sector for the housing industry peaked in 2005, buying pressure had been increasing as bullishness (optimism) rose from 80% toward 90% and then toward 100%, but from that extreme of bullishness, the chance for another big increase in bullishness was neglible and the risk of an increase in selling pressure was extreme.

After extremes of optimism, waves of conservatism naturally follow. The more extreme the optimism, the more extreme the conservative reaction tends to be. US Housing stock sector prices fell over 80% (so far).

Here is a chart of the US Financial sector which also fell more than 80% (but in a shorter time period). The price decline was led by companies including insurance giant AIG, mortgage companies Fannie Mae, Freddie Mac, and Countrywide, plus Merrill Lynch, Bear Stearns, Lehman Brothers, Washington Mutual Bank, and other major US financial institutions that all faced bankruptcy by 2008.

So, when people say that the market price of silver or Enron stock shares is a certain amount, that is not an indication of the market value of all silver or of all Enron stock shares. That is only an indication of the current price of a tiny portion of available shares in the context of the recent past of the relative pressure of buying or selling.

If a seller’s market switches to a buyer’s market, like what happened with Enron, there may be a sudden recognition that all of the shares of that company’s stock are not worth what a few of them sold for recently. Likewise, if a buyer’s market switches to a seller’s market, a discounted item can rocket in purchasing power, such as the rocketing of the purchasing power of the Japanese currency, the Yen, across the last two decades.

If I had to pick two markets that are currently most over-valued, it would be real estate and all insurance policies. The thing about insurance policies (including the annuities sold by insurance companies) is that they are in the business of risk, yet they do not have enough money to keep all of the promises that they make. Their business thrives when the dollar amount of new claims is far below the dollar amount of new revenues. Their business can collapse suddenly if the dollar amount of new revenues does not cover the dollar amount owed for incoming new claims.

The insurance industry is a classic ponzi scheme of paying old claims (old liabilities) out of their revenues from current investors (premiums). They only have a small fraction of the cash available to cover the vast promises that they have made at any particular time.

The speculative optimism toward real estate may be currently even more extreme than the optimism toward insurance companies or stock prices of companies like Enron. Even after a recent 50% decline in prices in major markets like Phoenix, Las Vegas, as well as the multi-decade drop in distant places like Tokyo, the blind optimism of many real estate investors is such that they still look to political interventions to boost their position, like a new tax credit to draw more buyers in to real estate at the expense of mainstream taxpayers. Such political redistributions of buying pressure tend to eventually produce sudden destabilizing of overall economies as buying pressure that otherwise might have gone in to something more adaptive like energy efficient housing or energy efficiency transportation is instead diverted toward pouring taxpayer money toward subsidizing the value of existing buildings.

Even after huge declines as well as obvious warnings from other markets worldwide, most investors focus away from those who predicted the real estate decline and instead argue about who is to blame or who should pay for government rescues for the gambling of high-risk real estate speculators. Instead of reviewing the warnings made in the 1990s or early last decade or the more recent updates from those same forecasters, many are so optimistic about real estate that they pretend that the sales prices when 2,000 units a month were being sold in a particular area will be anywhere close to the sales prices if 100,000 units are listed for sale in a single month in that same area, with all 100,000 of those sellers competing for the attention of even fewer remaining buyers than back when 2,000 units a month were sold. Of course prices fell 50% quickly. Given that I among many of those who forecast exactly that, I am clear that the 50% decline is just the first wave of a much longer decline, closer to what has manifested in Japan in the last 21 years, if not much more extreme. ;)